What is Shareholder’s agreement?

20 Aug 2018  Read 1083 Views

The Shareholders are the actual owners of a company. Shareholders of the company reap the benefits of the business success by way of increased stock valuation or in the form of dividends and profits. In the event of the company incurring losses, the share prices would fall or the shareholders suffer a decline in their portfolio’s value. It is important to uphold the rights of the shareholders. The disputes between shareholders are often settled according to the company’s Article of Association until a proper shareholder agreement is drafted. In other words, an agreement entered into by the company and its shareholders describing the rights and obligations is called the Shareholder’s Agreement.

What is Shareholder’s agreement?

A shareholder’s agreement is an agreement that regulates the relationship between the Management of the company and the shareholders. It governs the ownership of the shares, protection of the rights and obligations of the shareholders, and the way in which the company is run. This contract sets out the responsibilities of shareholders, liabilities of shareholders, rights of shareholders, and their obligations. It is normal to combine the terms of a shareholders’ agreement with a specifically drafted set of Articles of Association for the company. Shareholders’ agreements are often used as a safeguard and to give protection to shareholders, because (amongst other things) they can provide for what happens if ‘things go wrong’. An agreement can provide for many eventualities including the financing of the company, the management of the company, the dividend policy, the procedure to be followed on a transfer of shares, deadlock situations, and valuation of the shares. Although the company’s articles of association and company law will help to some extent, a fully considered and well-drafted shareholders’ agreement can act as a safeguard and give shareholders more protection against these types of scenarios.

The agreement gives corporations a way to: 

  • Control voting and ownership of the company 

  • Set a method for settling disputes

  • Describe a way to accept future capital contributions by new owners

 

The Advantages of Shareholders’ Agreements

In the event of a company not having a Shareholders Agreement, then any disputes arising between shareholders or directors will have to be settled by what is contained within the Articles of Association. The Articles lay down the rules on the functioning of the company. The Shareholders’ Agreement gives a contractual remedy in case its terms are broken. Let us elaborate on the benefits of this Agreement

  1. Privacy- The company’s shareholder agreement is a private agreement between the shareholders and which need not be published anywhere by the company nor it is required to be pinned down in any of the company’s registers.

  2. Pre-establishment- A shareholder’s agreement can be made even before the establishment of the company which could include the issuance of shares and how funds will be generated by the company. It then gives shareholder’s clarity on the type of contract and what are the rights, duties, and liabilities in the shareholder's contract framed to build the company and how the company is going to function.

  3. Protection to minorities- Shareholders agreement safeguards the rights of minorities. As the decisions among shareholders are made according to the majority voting it is very likely that minors’ rights get violated by the shareholders. However, in the case of the shareholder’s agreement, a majority of 75% is required which is higher than other agreements. The requirement for all shareholders to approve certain decisions ensures that the minorities have a say in the important decisions that impact the company. 

  4. Resolution- A resolution clause in the agreement is helpful to take decisions when the conclusion isn’t achieved by majority voting and a situation of deadlock arises, then the resolving clause of the agreement can be activated and the ways mentioned in resolving clause can help in the judgment.

What are the clauses that need to be included in a Shareholders Agreement?

  1. Management- Probably the most important clause to be included in a shareholder’s agreement is the management clause. This clause should include the appointment and removal of directors, their remuneration, frequency of board meetings and decision making. Thus, it is a basic as well as an important clause to be added to this agreement.

  2. Provisions regarding the Issue or Transfer of shares- Provisions regarding the issue or transfer of shares in special circumstances shall also be mentioned like in case of death, insolvency, retirement, etc. Further, the company can also mention drag along or tag along clause in the sale provision which will help resolve a dispute regarding the sale of the shares occurring between majority and minority shareholders. 

It may also include the Right of First Refusal which protects the company and the existing shareholders from sales of stocks to a competitor company. In the event of a shareholder selling his share, a clause in the shareholder’s agreement should state that such a shareholder will have to show the right to match an offer received from a third party. 

  1. Deadlock- A company’s shareholders agreement works on majority principal, very often a situation of deadlock arises, to resolve these deadlocks the agreement shall include a deadlock resolution clause which shall determine the ways to resolve that issue. Russian roulette, mediation, tax-shootout are a few ways to solve a deadlock.

  2. Accession procedure- To determine the process of allotting new shares and transfer of old shares a clause named as accession clause can be added. This clause is not a mandatory clause but can be added for better share management in the company.

  3. Non-competing clause- This can be added in the agreement to prevent shareholders to be approached by other competing companies, this clause can be made applicable for time being a shareholder is in contract with the company or even after that.

  4. Buyout provisions- This clause may contain a provision to be followed when one person chooses to be relieved of his shareholder's rights, the company may include provisions such as bidding in this clause.

  5. Dispute resolution clauses - These should be clearly defined especially on the following points – mode of dispute resolution, place of such dispute resolution, powers and duties etc.

Conclusion

Shareholder’s agreement is a mechanism that saves the company from losses and protects its interest. Make sure that the terms not ambiguous, but precise in interpretation. Clarity in listing out the rights and obligations of both parties – i.e. shareholders and the company will create a balance between shareholder interests and the company’s interests.

About the Author: Bernadine | 31 Post(s)

An MBA Finance graduate, having worked in the Telecom and Banking sector as a Risk and Compliance Manager. An avid blogger with a penchant for traveling

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